Game Theory: OPEC Cartel

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Transcript of Game Theory: OPEC Cartel

-Created in 1960 between Iran, Iraq, Saudi Arabia, Kuwait and Venezuela-Created to prevent the world's largest oil producers, refiners and marketers from lowering the price of oil-Coordinate and unify petroleum production policies, and ultimately control price and supplyOPEC-Rich nation-Numerous oil reserves (16% of world)-More market power-Lower costs of production-Perceivably more control being within OPECSAUDI ARABIA-2 parties-No collusion-Interdependence-Reactionary - strategy based on opponents actions-Payoff matrix

-Oil was relatively more inelastic back in the 1970's, giving OPEC more power to set a higher price as demand is relatively unresponsive to changes in price.OPEC in the '70sOPEC today- OPEC's share of world oil producers has now dropped significantly, to less than 40% of the market. The majority of oil being produced is from non-OPEC countries.

- An increase in oil suppliers has now lessened OPEC's power to set prices and control the market, and so their power as a cartel has lessened significantly.

- However, the world oil market is still considered an oligopoly because of the difficulty to enter, the extremely high production costs associated with oil extraction and refining, and limited suppliers.AffluentDevelopingConsider the following quote from The Economist magazine (‘Viennese Twirl’, 27/11/2014):“CARTELS work best when the members like and trust each other, when the penalties for breaching the rules are severe, and when outsiders are too weak to matter. OPEC, the cartel which controls 40% of the world’s oil production, fails on all counts. That makes bold decisions at its meeting today in Vienna unlikely, and sticking to whatever it agrees on even less likely still.”

a. Using your understanding of game theory, explain why cartels ‘work best when the members like and trust each other’.

b. Using hypothetical (but plausible) numbers, simulate what is happening within OPEC at the moment (Hint: use a two-country model, such as Saudi Arabia and Venezuela).Maximise prod Minimise prodMinimise $Maximise $Drive out compIndifferentLow cost prod High cost prodIncrease supplyDecrease supplyINCREASE PRODUCTION